Italian Economics

Can Italy's New Leader Trim a Bloated State?

Incoming Italian Prime Minister Letta speaks to the media in Berlin on April 30

Enrico Letta, Italy’s new prime minister, says he can reinvigorate his country’s ailing economy by slashing taxes and downsizing government.

Italy can “boost growth without compromising the necessary process of restructuring of public finances,” Letta told Parliament before a successful Tuesday confidence vote that enabled him to install a new government. Letta plans to roll back taxes imposed by his predecessor, Mario Monti, while offsetting the lost revenues with as-yet-unspecified budget reductions.

Lettanomics could represent the first big test of the anti-austerity movement that has been gaining steam across Europe. Will it work?

There’s no question that tax cuts, including the suspension of a controversial property tax, will be a relief to austerity-fatigued Italians. And a dose of stimulus certainly seems in order: Italy has been mired in recession for over two years, with unemployment at 11.5 percent. “The high tax burden and lack of growth creates a vicious circle,” says Riccardo Barbieri, chief European economist at Mizuho International in London.

What’s more, there’s plenty of government waste that could be trimmed without reducing benefits and services to ordinary Italians. Letta has already said he wants to abolish provincial governments, which he considers an unnecessary layer of bureaucracy, letting regional and city governments absorb their functions. He would also prohibit members of Parliament from earning double salaries when serving simultaneously in the cabinet.

Those changes would only scratch the surface, though. “The government sector is primarily a job-creation machine,” Barbieri says. “Public procurement, public-sector entities, ministries—there are way too many of them, and they are too expensive.” Moreover, the salaries and benefits paid to Italian lawmakers and top civil servants are well above European averages.

The question is whether Letta’s government, cobbled together to fill a vacuum created by inconclusive elections in February, can muster the political support to carry out these changes. Even Monti, despite his reputation as a pro-austerity pit bull, made scant progress on downsizing government, Barbieri says. In fact, he says public spending rose from 50.7 percent of gross domestic product to 51.1 percent during Monti’s tenure, although overall economic shrinkage largely accounts for the higher percentage.

In his first official trip as prime minister, Letta headed to Berlin on Tuesday to reassure German Chancellor Angela Merkele that he’s serious about maintaining the budgetary rigor begun by Monti, who lowered Italy’s budget deficit to the European Union limit of 3 percent of gross domestic product last year. Germany, for its part, has been signaling recently that its insistence on strict austerity may be softening.

Investors seem willing to give Lettanomics a chance. Yields on Italian sovereign debt have fallen to their lowest level in more than two years, which in turn eases pressure on the government’s finances. And while Italian stocks slid on April 30, they’ve risen in recent days as it became clear that Letta could form a government.

The respite could be brief, unless Letta can show he has the political muscle to attack entrenched interests—including the lawmakers who will vote on his program. Says Barbieri: “They will have to go for the spending cuts that will hurt politically.”